I believe the market is vastly underestimating the possibility of oil prices declining in a fashion similar to the latter half of 2008.
My reasoning for this has absolutely nothing to do with looking at inventory levels, or really any other kind of fundamental data. Rather, instead of looking directly at oil data, it’s worth looking at what’s going on with substitutes to oil.
Take a look below at the price ratio of the Guggenheim Solar ETF (NYSEArca: TAN) relative to the iShares S&P 500 (NYSEArca: IVV).
As a reminder, a rising price ratio means the numerator/TAN is outperforming (up more/down less) the denominator/IVV. Note that this is a relative way of looking at markets. The numerator can go down, but so long as it goes down by less than the denominator, the price ratio trends higher. The same is true in reverse.
You can see from the far left of the chart that the price ratio was trending down pre-September 2008, as oil prices were on their way down from $147 a barrel. The idea here is that the only thing that really matters for alternative energy investors is what expectations are for future oil prices. After all, higher oil prices means that the breakeven point of using substitute sources of energy gets closer and closer to where alternative demand jumps.
The price ratio has been trending lower for some time now. Much of the weakness is actually related to Europe, since a good chunk of the companies in the solar energy ETF get subsidies from governments, many of which are likely to evaporate given what appears to be a European recession. However, the magnitude of underperformance in solar stocks should not be ignored. They may be warning of a substantial decline in oil prices to come.
The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The article does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.